The stock market was turned on its head last year when the Federal Reserve abandoned its easy money policy. Many investors say the impact is just beginning to spread through markets.
Analysts from some of the largest US banks expect the stock market to retest its 2022 lows in the first half of the new year before starting to recover. Goldman Sachs experts expect the S&P 500 to end 2023 at 4000 points, up about 4% from where it was in 2022.
The volatility has hit the market giants particularly hard. Five big tech stocks accounted for about a quarter of the U.S. stock market’s total declines over the past year, a harsh sell-off reminiscent of the dot-com bust two decades ago.
The S&P 500 ended the year down 19% after the conditions that had paved the way for years of almost uninterrupted stock market rally and run of some of the most speculative bets evaporated.
Cryptocurrencies plummeted, splashy IPOs all but dried up, and blank check companies imploded at the end of the year, a stunning reversal of the mania that has gripped the markets for the past two years.
“We’re in a world where interest rates are back,” said Ben Inker, co-head of asset allocation at Boston-based money manager GMO, which has $55 billion in assets under management.
One of the biggest flip-flops happened below the market surface. Investors dumped the flashy tech and growth stocks that had fueled this market’s gains over the past decade.
And value stocks — traditionally defined as those that trade at low multiples of book value or net worth — have enjoyed a resurgence after years of lackluster returns.
The Russell 3000 Value Index outperformed the Russell 3000 Growth Index by almost 20 percentage points, its largest range on Dow Jones Market Data records dates back to 2001.
Now, Mr. Inker and other investors looking for opportunities after a miserable year for both stocks and bonds say this is just the beginning of a major stock market rotation.
Money managers say they are positioning themselves for an environment that bears little resemblance to what many have become accustomed to after the last financial crisis. The era of ultra-low bond yields, benign inflation and accommodative Fed policy is over, they say, and the market’s winners and losers are likely to be recalibrated for years to come.
“Some investors have tried to justify nosebleed’s valuation levels,” said John Linehan, portfolio manager at T. Rowe Price. Now, “going forward, leadership will be more diverse.”
The Fed will keep raising rates and has indicated plans to keep them high until the end of 2023. Many economists are predicting an imminent recession, while Wall Street remains fixated on whether inflation will ease after repeatedly underestimating its staying power.
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Mr Linehan said he expects the run on value stocks to continue and sees opportunities in financial stocks thanks to higher interest rates. Others say energy stocks’ steep run isn’t over yet. Energy stocks within the S&P 500 are up 59% over the past year, the best run in history.
Some investors are positioning themselves for bond yields to continue rising, which could potentially deal a bigger hit to tech stocks. These stocks are particularly vulnerable to higher interest rates, as in many cases they are expected to post outsized gains over the next few years, a vulnerability in a world now emphasizing secure returns.
The 10-year Treasury bond yield ended 2022 at 3.826%, the largest one-year yield rise since at least 1977, while bond prices plummeted. From risky corporate bonds to safer municipal debt, yields soared to some of their highest levels in the past decade, giving investors more opportunities to park their money.
“I don’t think technology will define the next decade,” said Mark Luschini, chief investment strategist at Janney Montgomery Scott. “That one-size-fits-all idea that you just buy a broad tech index or the Nasdaq 100 has changed.”
The Fed has indicated that it plans to keep interest rates elevated until the end of 2023.
Photo: Ting Shen/Bloomberg News
The tech-heavy Nasdaq 100 index fell 33% in 2022, underperforming the broader S&P 500 the most since 2002.
Investors pulled about $18 billion from mutual funds and exchange-traded funds that tracked technology through November, and were on track for the largest annual outflows recorded in Morningstar Direct data since 1993. Funds tracking growth stocks saw outflows of $94 billion, the highest since 2016.
Meanwhile, investors have been bargain-hunting the stock market and piled into value funds. These funds saw inflows of more than $30 billion and made withdrawals for the second year in a row.
“Profitability and free cash flow will be very important in the year ahead,” said Tiffany Wade, senior portfolio manager at Columbia Threadneedle Investments.
Ms Wade said she expects the Fed to be more aggressive than many investors are currently predicting, leading to another difficult year. If the Fed halts rate hikes next year, they think growth stocks could rebound.
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Other investors are heeding the lessons of the post-tech burst years, when value stocks outperformed their growth peers.
Even after last year’s sharp declines, the technology sector is trading at a wide premium to the S&P 500. Stocks in the energy, financials, materials and telecoms sectors still appear cheap relative to the broader benchmark, according to data dating back to 2010 from Bespoke Investment Group.
Also, big tech companies face stiffer competition and potentially tighter regulation, a setup that could disappoint investors who have developed high expectations for the group.
Its streak of impressive top-line growth is also likely to falter, analysts at Goldman Sachs said in a recent note. Aggregate revenue growth for megacap tech stocks is expected to have risen 8% in 2022, below the 13% growth of the broader index.
“I just don’t think the winners of the previous regime will be the winners of tomorrow,” said Eddie Perkin, Eaton Vance Equity’s chief investment officer. “They are still too expensive.”
Write to Gunjan Banerji at [email protected]
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